Sbarro Chapter 11 filing, more details

As no surprise, Sbarro, the mall and plaza centered pizza operator, filed Chapter 11 reorganization this morning. Sbarro operated 466 company units, and has 555 franchised units, 217 in the US and 338 international. This has been in the works for months.

The plan is for about $195M in debt cancellation, with debtholders taking equity stakes.  The company hopes to get EBITDA back to $50M by 2015, versus $38M in FY-10.

Sbarro was acquired by private equity firm MidOcean in 2006, and has had a hard time since. At year end 2010, its loan covenants required $43M of EBITDA but came in only at $38M. This was a 34%  EBITDA decline since 2007.  

At the time of the 2006 acquisition, the Sbarro purchase price (EV) to EBITDA was estimated at 8 times, a bit higher than the long term historical 5 to 7 times restaurant range but not as high as others in the 11-12 range (Dunkin, Quiznos) that were worked in that era.

According to the CEO's petition (attached), same store sales fell 2.2%, 4.5% and 2.0% in 2008/2009/2010 but EBITDA fell $19M.

The petition doesn't mention franchisees other than that franchisee revenue was attributed to be $14M and EBITDA $10M. 

This outcome goes back to our recent note on BMM that private equity failures relate back to the strength of the brand. A 8 times factor might not have been too high versus others, but clearly was too high for Sbarro operations to service.

We have to think also some other moving factors were at play: same store sales were down but not drastically (like Arby's, for instance). Perhaps other expenses, such as PE firm management fees or other G&A costs (international franchsing G&A is expensive) had a play. And the 2006 initial projection seemed to have little downside tolerance..

About the author: John A. Gordon, Chain restaurant Earnings and Economics Experts, Pacific Management Consulting Group 

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Hedging Commodity Prices

John, here is what I don't understand:

"Like other food service and retail businesses, however, Sbarro’s financial  performance is sensitive to volatility in commodity prices and consumer discretionary spending, and the business has been negatively impacted by the recent global economic crisis.  

After being hard-hit during 2007 and 2008 by a surge in prices for its key raw materials (cheese and flour), Sbarro’s profitability continued to suffer following the fourth quarter of 2008 and most of 2009 as a result of unprecedented declines in mall traffic during the height of the economic recession."

Why did their hedging operations fail?  I don't see any explanation of this failure.

Sbarro Cost Hedging and other store economics points

Good question, Michael. At their unit count size and G&A structure, one would expect some organized cost mitigation.

The CEO's declaration is sillent on detailed annual gross margins, so we consulted the Sbarro 10K (filied because of debt/credit requirements).

The last filed 10K (2009 YE) shows cost of goods sold as percentage of company stores sales moving from 20.5 % in 2007, to 22.8% in 2008, to 20.4% in 2009 and at 21.0% as of 9 months Q3 2010. Since these 10Q and 10K SEC filings were written with the lenders in mind, the management discussion and analysis of operations issues is sparse. 

The 10K didn't note an organized cost containment program underway. Being in the low or every low 20s isnt a bad number for pizza operators, but Sbarro has to have high rent costs.  

We can rough out that company store AUV was about $669K, and franchisee AUV at $564K in 2009. We can't get to store level EBITDA or rent costs from the displays. 

Average check or pricing actions were not disclosed, so we can't tell if Sbarro tried to price up. Probably, they felt constrained by the weak mall traffic trends.

General and Administrative costs, which might contain PE firm management fees, bounded around, from $27M in 2007 to $31M in 2009, with the company noting "field infrastructure personnel and training", and SOX compliance costs as factors.


John A. Gordon

Pacific Management Consulting Group

Sbarro's Private Equity Dilemma

Seems like Sbarro's problems are due to their high rents and not failed hedging programs. Majority of Sbarro locations are in high traffic locations, such as, highway service areas, airports, and shopping malls. Unlike other franchises that claim to be "Recession Proof", Sbarro certainly doesn't fit the bill.

U.S. News reported in 2009:

Sbarro. (Privately owned; about 5,500 employees). It’s not the pizza that’s the problem. Many of this chain’s 1,100 storefronts are in malls, which is a double whammy: Traffic is down, since consumers have put away their wallets. Sbarro can’t really boost revenue by adding a breakfast or late-night menu, like other chains have done. And competitors like Domino’s and Pizza Hut have less debt and stronger cash flow, which could intensify pressure on Sbarro as key debt payments come due in 2009.

Not much is said on MidOcean Partners holding period investment performance to date. Nation's Restaurant News reports Sbarro debt to be $486.6M. MidOcean purchased Sbarro, in 2007, for approximately $450M by leveraging $208M in debt financing. Fidelity Financial Group reports:

MidOcean Partners, whose founders spun out of Deutsche Bank (DBKGn.DE) early last decade, bought Sbarro in January 2007, at the height of the then-booming economy, for approximately $450 million, using at least $208 million in debt financing.

Although I haven't delved into MidOcean's dividend history, it's pretty obvious that they repaid their equity investments by fully leveraging the entire price tag of the 2007 buyout.  Apparently, MidOcean Partners has pulled off the classic American Private Equity Buyout by loading Sbarro up with debt, bleeding the cash, and then restructuring it's balance sheet via Chapter 11 bankruptcy. All of it is perfectly legal - and, it doesn't require a bunch of paperwork for either the franchisor or the franchisees, just the lawyers!